Sunday, January 12, 2014

Rules on Retirement Withdrawals / Tackling readers' questions about taxes, Social Security benefits and IRA conversions

Karen Damato for the Wall St Journal writes: I've got a hypothetical tax question. Say someone has a tax-deferred account (non-Roth) with a contribution value of $200,000 and a current value of $600,000.  What if the entire $600,000 was placed in a federal- and state-tax-free municipal bond for one year and then withdrawn? Would there be taxes on the $400,000 gain even though it is withdrawn from a tax-free investment?
Glenn Biron
Costa Mesa, Calif.
Sorry, but it isn't possible to escape taxation on withdrawals from an individual retirement account by temporarily investing the money in the IRA in tax-free muni bonds.
"It doesn't matter what is going on inside the IRA. Whatever comes out is going to be taxable" if the account was funded with tax-deductible contributions, says Bill Fleming, a Boston-based managing director for PricewaterhouseCoopers.
If you didn't deduct some of your contributions, part of your withdrawals would be tax-free. But that is strictly a function of the tax rules for IRAs, not the investments in the account.


My wife and I are both age 65. We both worked and have our own Social Security benefits. She started collecting her benefits at age 62. I plan to wait until age 70 to start mine. When I reach age 66, can I start collecting half of my wife's benefit as a monthly spousal benefit? If so, would it in any way affect my benefit at age 70? When I start collecting at age 70, can she switch and start collecting half of my benefit instead of her own?
Larry Heimsoth
Thousand Oaks, Calif.
The scenario you outline is indeed a possibility. At your full retirement age of 66 you could file solely for a spousal benefit. While collecting that, you would accrue "delayed retirement credits" that increase your earned benefit by 8% of your full-retirement-age benefit for each year you delay up to age 70. When you started collecting your own benefit at age 70, it would be the same as if you hadn't already been collecting a spousal benefit. And your wife could then start her spousal benefit if it is higher than her earned benefit.
But this may not be the best Social Security claiming strategy for the two of you, says William Reichenstein, a finance professor at Baylor University and a principal
If your wife's career earnings have been a lot lower than yours, it might be more advantageous for you to skip collecting a spousal benefit on her earnings and instead speed up your wife's collection of a spousal benefit based on your earnings, he explains. You would make that possible when you turn 66 by filing for and suspending your benefit. With this approach, as with your initial idea, you would accrue delayed credits while putting off collection of your earned benefit.
The math of maximizing a couple's Social Security can be complex, and a variety of online tools can help. A September 2013 review by The Wall Street Journal gave top marks to Mr. Reichenstein's website and, which both charge fees.


We are thinking of converting our IRAs to Roth IRAs. We are both 66 and will wait to collect Social Security until 70. We have to take minimum distributions at 70½. At that point, our income will jump and move us into a higher tax bracket. We don't need the IRA money for income; we just want to pass it down to our three children. Does it make sense to start converting our IRAs to Roth IRAs even with the big tax hit we will take during the conversion?
Richard King
Virginia Beach, Va.
For retirees who don't expect to need to tap their IRAs in their lifetimes, converting some or all of those assets to Roth IRAs is indeed worth considering. By making the change now, you would lower your taxable income once you reach 70½. That might lower the taxation of your Social Security benefits, notes Maria Bruno, an investment analyst in Vanguard Group's Investment Strategy Group.
And down the road, your heirs would inherit accounts from which they would take a stream of tax-free income, rather than taxable income. That would be particularly valuable if their incomes (and tax brackets) are high.
Converting at least some of your IRAs "could provide flexibility now and for the children," says Ms. Bruno, who adds that partial conversions over multiple years could limit the tax pain for you. Before proceeding, I'd suggest having a tax professional analyze possible conversions of varying sizes and the likely impact on your tax bill.


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